Select handful to emerge winners in rebuilding

The savage floods that have put much of Queensland under water dominated headlines this week, but that couldn’t dampen the optimism in the market as small cap stocks put on an impressive performance.

The S&P/ASX Small Ordinaries is on track to post a gain of around 2.5 per cent over the past five days compared with a gain of under 2 per cent by the top 200 stock benchmark.

Investors are starting to scout more aggressively for buying opportunities in the wake of the disaster, on the belief that the rebuilding exercise in Queensland will provide some sort of a windfall for construction-related companies and even retailers as residents have to replaced lost belongings.

While every crisis creates winners and losers, investors shouldn’t get too excited about the potential upside as resources have to be taken away from some areas to fund new spending on the reconstruction. The size of the pie has shrunk, not expanded.

Some experts estimate the crisis will cost the economy up to 1 per cent of gross domestic product, or around $13 billion. The earnings risk for the next six months is clearly on the downside for most.

But this isn’t to say some small caps won’t experience a boost in demand for their products or services. Investors will just need to be careful in identifying these opportunities.

JPMorgan has shed some light on this issue and estimated that for every one emerging company in its research universe that stands to benefit from the clean-up effort, at least two will suffer a negative impact.

Investors could be forgiven for thinking that corporate earnings will be largely unaffected even though the scale of the human tragedy is unmatched in at least 3½ decades, as a wide range of companies with large operations in the state have come out to reassure the market.

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Mining contractors
Austin Engineering
and
Monadelphous Group
on Friday said that the flood did not have any material impact on their facilities and equipment and that it was largely business as usual for them.

Temporary accommodation provider
Nomad Building Solutions
also told investors its Queensland businesses are mostly unscathed and that it has secured more than $11 million in new contracts in that state in the past month alone.

However, real winners from the rebuilding will be few and far between. JPMorgan has highlighted three potential small companies that could actually see an increase demand for their goods are services.

Diversified industrial goods distributor
GUD Holdings
is one as it is the largest manufacturer of water pumps in Australia through its Davey subsidiary.

Interestingly, its share price made a sharp U-turn since worries about the wet weather intensified at the start of December and GUD has surged ahead by 12.9 per cent.

The broker is anticipating a positive lift in demand for Davey pumps as the clean-up begins, which is likely to ease some concern that the stock was approaching fair value as it is getting close to the average broker price target of $10.75 a share.

GUD was trading 5¢ firmer on Friday afternoon at $10.16.

But the positive impact from the clean-up effort will probably be more greatly felt by
Tox Free Solutions
and
Transpacific Industries
.

Tox Free’s Barry Brothers subsidiary that was bought from Programmed Maintenance provides industrial cleaning services including drain cleaning, decontamination and high pressure jetting in the east coast and JPMorgan suspects that it will be “very busy" over the next several weeks.

This probably explains why the stock has rallied close to 7 per cent this week, which puts it on a one-year forward price-earnings multiple of 13.8 times. While that could look like fair value in relation to the market, the multiple is well below its five-year average of close to 21 times.

Most brokers are urging investors to buy the stock with an average price target of $2.70 a share. Tox Free jumped 2.7 per cent to an eight-week high of $2.32 on Friday.

Transpacific is the third best performer on the ASX Small Industrial Index for the week with a stunning gain of 10.6 per cent as the company is the leading provider of waste management services in Queensland.

“Flooding inevitably generates significant quantities of liquid and solid waste that will need to be disposed of," said JP Morgan. “Transpacific’s industrial cleaning business is also likely to be very busy in the clean-up phase."

On the downside, there could be some damage to its Queensland-based facilities and disruption to regular solid waste collection activities. Transpacific’s head office on Coronation Drive in Brisbane is likely to have been inundated too.

But unless a material earnings upgrade in forecast is in the wings, the stock is looking fully valued on a P/E of close to 15 times.

The stock gained 3¢ to $1.415 in afternoon trade. The average broker price target on Bloomberg is $1.33 a share.